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Financial Sector

Unexploited Gains from International Diversification: Patterns of Portfolio Holdings around the World

Sergio Schmukler's picture

The increase in global financial integration over the last twenty years has been remarkable, and U.S. institutional investors have been significant participants in this growth. Given standard economic theory, one would expect to see greater international diversification accompanying the expansion of global investment opportunities. To date, however, evidence on how investors actually allocate their portfolios around the world and what determines it is still limited.

In a joint paper with Roberto Rigobon, we aim to fill the gap in the literature by constructing a unique micro dataset of asset-level portfolios for a group of important institutional investors, namely US mutual funds with international investments. To shed light on the drivers of globalization and investment across countries, we explore the structure of mutual fund families. We make within-family comparisons of the behavior of “specialized funds,” which can invest only in certain countries or regions, and “global funds,” which can invest anywhere in the world and thus have access to a larger set of instruments (more firms from more countries).

Reducing the Infant Mortality of African Exports: The role of information spillovers and network effects

Leonardo Iacovone's picture

Helping African exporters survive in international markets should be a high-priority item on the agenda of development agencies. African exports suffer from high “infant mortality” compared to other regions of the world: Figure 1 shows that the life expectancy of export spells originating from sub-Saharan Africa is about two years (half the level for East Asia and the Pacific), with a median—not shown—around one year. That is, half of the continent’s exporters don’t make it past the first year. Such “hit-and-runs” on international markets cannot establish networks, relationships, and credibility.

Figure 1: Average Spell Survival, by exporting region

Source: Author's calculations, from COMTRADE data

Optimal Financial Structures for Development? Some New Results

Asli Demirgüç-Kunt's picture

One of the interesting debates in the finance and development literature is on financial structures: does the mix of institutions and markets that make up the financial system have any impact on the development process? Last week we hosted an interesting conference on the topic at the World Bank (click here for the agenda and papers). Those of you who have been following this literature will know this is not the first time this topic has been discussed – we held a conference on financial structures over ten years ago.

What do financial structures look like? How do they evolve with economic development? What are the determinants and impact of financial structures? Years ago Ross Levine and I, along with many others, tried to answer these questions and saw clear patterns in the data. One stylized fact: Financial systems become more complex as countries become richer with both banks and markets getting larger, more active, and more efficient. But comparatively speaking, the structure becomes more market-based in higher-income countries. We also saw that countries did not get to B from A in a single, identical path. You didn’t have any market-based financial structures in the lowest-income countries, but as soon as you got to lower-middle income, financial structures became very diverse: Costa Rica was bank-based, whereas Jamaica was much more market-based; Jordan was bank-based, Turkey was market-based etc. etc. So countries were all over the place and the correlation between GDP per capita and financial structure was less than 30 percent.

Cross-border Banking in Europe: Implications for Financial Stability and Macroeconomic Policies

Thorsten Beck's picture

Understanding the role of banks in cross-border finance has become an urgent priority. The recent Global Financial Crisis and ongoing European crisis have shown the importance of creating the necessary regulatory and macroeconomic conditions for a Single European Banking Market to function properly in good and in tough times. Together with five other economists (Franklin Allen, Elena Carletti, Philip Lane, Dirk Schoenmaker and Wolf Wagner) I have  published a CEPR policy report that analyzes key aspects of cross-border banking and derives policy recommendations from a European perspective. We argue that for Europe to reap the important diversification and efficiency benefits from cross-border banking, while reducing the risks stemming from large cross-border banks, reforms in micro- and macro-prudential regulation and macroeconomic policies are needed.

The benefits and risks of cross-border banking have been extensively analyzed and discussed by researchers and policy makers alike. The main stability benefits stem from diversification gains; in spite of the Spanish housing crisis, Spain’s  large banks remain relatively solid, given the profitability of their Latin American subsidiaries. Similarly, foreign banks can help reduce funding risks for domestic firms if domestic banks run into problems. However, the costs might outweigh the diversification benefits if outward or inward bank investment is too concentrated. Based on several new metrics, we find that the structure of the large banking centers in the EU tends to be well balanced. However, problems are identified for the Central and Eastern European countries which are highly dependent on a few West European banks, and the Nordic and Baltic region which are relatively interwoven without much diversification. At the system-level, we find that the EU,  in contrast to other regions, is poorly diversified and is overexposed to the United States.

Generating Jobs in Developing Countries: A Big Role for Small Firms

Asli Demirgüç-Kunt's picture

These days, job creation is a top priority for policymakers. What role do small and medium enterprises (SMEs) play in employment generation and economic recovery? Multi-billion dollar aid portfolios across countries are directed at fostering the growth of SMEs. However, there is little systematic research or data informing the various policies in support of SMEs, especially in developing countries. Moreover, the empirical evidence on the firm-size growth relationship has been mixed. Recent work of Haltiwanger, Jarmin, and Miranda (2010) in the U.S., suggests that (1) Startups and surviving young businesses are critical for job creation and contribute disproportionately to net growth and (2) There is no systematic relationship between firm size and growth after controlling for firm age. It is not clear whether these findings apply in developing countries where there are greater barriers to entrepreneurship, and where venture capital markets that finance young firms are not as well developed as in the US.

In a recent paper Meghana Ayyagari, Vojislav Maksimovic and I put together a database that presents consistent and comparable information on the contribution of SMEs and young firms to total employment, job creation, and growth across 99 developing economies. Our sample consists of 47,745 firms surveyed in the period 2006-2010. We then examine the relationship between firm size, age, employment, and productivity growth and how this varies with country income and find the following:

Should It Be our Business to Promote Business Training?

Bilal Zia's picture

Firms in developing countries face many constraints, from lack of access to finance and physical capital to poor infrastructure. Recently, however, there has been a growing focus among researchers on “managerial capital”, or business skills, as an important determinant of entrepreneurship in developing countries. Policymakers have been equally interested in the perceived deficit of managerial capital, and have been pouring resources into financial and business literacy education programs around the world (see my earlier post on The Fad of Financial Literacy?).

Yet we still have a very incomplete understanding of the effectiveness of these programs, and their specific impact on business outcomes. Until recently, there were only two completed randomized impact evaluations of business training programs in developing countries: one in Peru for rural women, which found positive effects on certain business practices but not on profits (Karlan and Valdivia, 2010), and the other in the Dominican Republic, which found that basic rules-of-thumb-based training had a greater effect on business outcomes than formal business training (Drexler, Fischer, and Schoar, 2010).

Does Competition Make Banking More Dangerous?

Thorsten Beck's picture

Post-Debate Update:

The debate is over, opening statements, rebuttals and closing remarks have attracted lots of comments and the votes been cast and counted. The results show that a (probably not very representative) majority do not think that competition is dangerous for stability, though the reasons for this might vary quite a lot. Some might have been swayed by my argument that it is regulation that makes banking more dangerous – if of the wrong kind. This is also consistent with Ross Levine’s view that the recent crisis "represents the unwillingness of the policy apparatus to adapt to a dynamic, innovating financial system." Understanding the links between competition, regulatory policies and stability is certainly a topic that deserves to be to be explored more – stay tuned for an update over the summer.

Original Post:

What's at the Top of the Agenda for the Financial Sector after the Crisis?

Maria Soledad Martinez Peria's picture

The 2011 Overview Course of Financial Sector Issues took place earlier this month at the World Bank's headquarters in Washington, DC. This annual event is sponsored by the Office of the Chief Economist of Finance and Private Sector Development, and it provides an overview of issues of current importance for policy-makers, researchers, and practitioners working in the financial sector. Speakers included a number of well-known thinkers and researchers on financial sector issues such as Simon Johnson, Ross Levine, and Franklin Allen, and attracted some 70 external participants from central banks, ministries of finance, and bank regulatory agencies representing 45 countries.

The theme of the course this year was Financial Sector Practices and Policies after the 2007-2008 Crisis (view the full agenda). Lectures, case studies, and panel discussions covered a broad spectrum of issues surrounding this theme, such as long-run policy lessons from the financial crisis, the role of the government in the financial sector after the crisis, bank risk management models before and after the crisis, bank resolution mechanisms, building crisis management capabilities, the future of bank regulation, macro-prudential regulation and stress testing banking systems, capital markets and pension systems after the crisis, to mention the main ones. Also, the course looked into longer-term issues related to the development of the financial sector, e.g. remittances, financial inclusion, SME finance, and microfinance.

Introducing the Global Financial Development Report

Martin Cihak's picture

How should we measure and assess financial development around the globe? Why has financial development progressed so quickly in some regions and countries while seriously lagging in other parts of the world? At what point does the financial sector become too large or too complex? What mix of banks, other financial institutions, and financial markets is the best from the broader development perspective? How to ensure healthy competition in the provision of financial services? Which policies help in supporting robust financial development, and which ones do not? And which ones help in providing people and firms with better access to finance?

These are just some examples of questions to be addressed by a new annual publication, the Global Financial Development Report (GFDR), a flagship report of the World Bank Group. As highlighted by its title, the report will have global coverage with a focus on finance and an explicit developmental angle. The GFDR will provide an overview and assessment of financial sector development around the world, with a particular attention on medium- and low-income countries. The preliminary target release date for the inaugural issue, GFDR 2013, is September 2012.

Should State Banks Continue to Play a Role in the Middle East and North Africa?

Roberto Rocha's picture

In the past three decades the role of state-owned banks has been sharply reduced in most emerging economies. This reflects a general disappointment with their financial performance and contribution to financial and economic development, especially in countries where they dominated the banking system. But despite their loss of market share, state banks still play a substantial role in many regions, especially in East Asia, the Middle East and North Africa, and South Asia (figure 1).

Figure 1 Share of state banks in total assets by region, various years, 1970–2005
(percent)

 

The arguments put forward to justify the continuing presence of state banks have included market failures (resulting from asymmetric information and poor enforcement of contracts) that restrict access to credit; the provision of essential financial services in remote areas (where supply may be restricted by large fixed costs); and the provision of countercyclical finance to prevent an excessive contraction of credit during a financial crisis. These arguments may well justify policy interventions in many countries, although it does not necessarily follow that state banks are the optimal intervention. Moreover, even where the presence of state banks may be justified, policy makers still face the challenge of ensuring clear mandates and sound governance structures in order to minimize political interference and avoid large financial losses.

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